Milk souring as record profit spurs herd expansions

March 13 (Bloomberg) -- Record dairy profits and milder weather are leading to a surge in milk supplies from Auckland to California, turning last year’s best-performing commodity contract into one of the worst of 2012.

Output in the U.S., the world’s largest producer, will advance 1.8% to a record 199.7 billion pounds (90.6 million metric tons) in 2012, the Department of Agriculture estimates. Futures traded on the Chicago Mercantile Exchange already fell 29% from a four-year high in August and may drop another 7.9% to $14.25 per 100 pounds by July, the median of six analyst estimates compiled by Bloomberg shows.

An estimated 30% jump in U.S. dairy exports led to the most profitable year ever for farmers, who expanded herds that now are the biggest since May 2009, USDA data show. Yields reached a record during an unusually mild winter. Supply is also rising in Australia and New Zealand, the largest exporter, and dairy was the only food cost tracked by the United Nations to decline last month.

“This blasted weather that most people have enjoyed, the dairy cows have really enjoyed it,” said Bill Brooks, an economist for INTL FCStone Inc. in Kansas City, who grew up on a dairy farm in Missouri and has covered the industry for two decades. “We’re going to see more milk production.”

Agriculture Index

Milk futures that jumped 31% last year, more than any of the 24 commodities in the Standard & Poor’s GSCI Spot Index, dropped 10% since Dec. 30 to $15.48 today. Only natural gas and arabica coffee fell more. The S&P GSCI Agriculture Index advanced 1.3% this year, as the MSCI All-Country World Index of equities rose 10%. Treasuries lost 0.5%, a Bank of America Corp. index shows.

U.S. dairy farmers had 9.236 million cows in January, the 14th herd expansion in 16 months, USDA data show. Each animal produced a record 21,345 pounds (9.7 metric tons) of milk last year. Fonterra Cooperative Group Ltd., the largest dairy exporter, shipped 246,000 tons in December, the most ever. Deliveries to its plants rose 9.8% in the eight months ended Jan. 31, the Auckland-based company said last month.

Rising supply may meet weaker gains in demand. China, the biggest buyer of U.S. agricultural products, is targeting economic growth of 7.5%, the lowest since 2004, Premier Wen Jiabao said March 5. The economy gained 8.9% in the fourth quarter, the slowest pace in 10 quarters.

Feed Costs

Declining milk prices and rising cattle-feed costs may require farmers to cull herds, reducing supply, said Chip Whalen, a vice president of education and research at Chicago- based Commodity & Ingredient Hedging LLC, which advises clients on managing commodity price swings. Corn futures averaged $6.78 a bushel in Chicago last year, the most in at least a half century. Record beef prices also may encourage more slaughtering.

“We’re going to go through another one of these cycles where we’re going to cull the herd,” said Shawn Hackett, the president of Hackett Financial Advisers Inc., a brokerage and consultant based in Boynton Beach, Florida. “We’re setting a stage for a significant slowdown in production growth, starting in the later part of this year,” said Hackett, who anticipates a rally to $18 in the second half of 2012.

While China may slow this year, the U.S. will expand 2.2% from 1.7% in 2011, according to the median of 79 economist estimates compiled by Bloomberg. U.S. consumption of fluid milk will reach 28.61 million tons this year, the highest since at least 1964, and cheese demand will advance to 4.83 million tons, the most since at least 1965, USDA data show. The U.S., with 4.5% of the global population, eats 32% of the world’s cheese production and drinks 6.2% of its milk, the department estimates.

Cull Herds

Farmers may be reluctant to cull herds. While losses this year may hurt some dairies, most are in better financial shape than in 2009 and 2010, so there won’t be a “wholesale decrease in cow numbers,” said Jon Spainhour, a broker and partner at Rice Dairy LLC in Chicago.

In 2009, the average for milk futures slumped to $11.56, a six-year low, before rebounding in 2011 to $18.55. Last year, the average dairy farm had net cash income of $239,800, the most ever, the USDA estimated Feb. 13, up from $158,100 in 2010 and $70,100 in 2009.

Exports were the “key factor” in last year’s rally, said Bob Cropp, an economist at the University of Wisconsin in Madison who has been studying the industry since 1966. U.S. dairy exports totaled $4.78 billion in 2011, up from $3.69 billion in 2010, according to the USDA’s Foreign Agricultural Service. Shipments will drop 2.2% in 2012, according to a report by USDA economist Milton Madison at a Feb. 24 forum in Washington.

Industry Projects

The industry is now facing more competition in export markets, said Brooks of INTL FCStone. Output in New Zealand, curbed by drought last year, may rise 8% to 10% this season, according to Southbank, Australia-based Dairy Australia, which raises levies from farmers to fund industry projects.

Production in Australia may rise 1.4% to 9.55 billion liters (2.5 billion gallons) in the year beginning July 1, the Australian Bureau of Agricultural and Resource Economics and Sciences said in a report March 6. Flooding last year limited output and disrupted transportation.

U.S. output is also rising on improving weather. The three- month period ended in January was the sixth-warmest-ever for that time of year, according to Brad Rippey, a meteorologist with the USDA. The four warmest all happened since 1998 and the other was in 1933-1934, the dust bowl era.

California Dairies

Milk production in California, the largest producing state, climbed 6.6% in January from a year earlier to 3.615 billion pounds, the highest on record for that month, USDA data show. There’s “milk coming out of our ears,” said Bill Schiek, an economist at the Dairy Institute of California in Sacramento, which represents processors in the state.

The drop in prices is no incentive to cut production for Ray Souza, who has 900 Holstein cows on his farm in Turlock, California. Farmers tend to react by increasing output because their costs remain similar, he said.

“We’ve never produced at this level before,” said the 65- year-old, who has been in the dairy business since 1973. “Cows produce more milk in the springtime than they do in any other part of the year. This spring seems to have started around the first of December.”